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Friday, March 01, 2002

The Cure Can Be Worse than the Disease

Last month I discussed the prisoners’ dilemma, in which everyone is motivated to behave in a way that leaves everyone worse off. One can appreciate market exchange by understanding how private property and voluntary exchange eliminate a destructive prisoners’ dilemma–one in which the best choice for everyone is to try to live at everyone else’s expense. The result is general poverty, coupled with the loss of freedom to a repressive state justified in the name of overcoming the prisoners’ dilemma.

But even when a country has a well-functioning market system, some government action is commonly justified as necessary to overcome serious prisoners’ dilemmas. For example, making sure that people obey the rules of the market (respecting the property rights of others and abiding by contractual agreements) can be thought of as overcoming a prisoners’ dilemma. If everyone else obeys the rules of the market, the economy will be extremely productive, but an individual can do better by stealing and defrauding others (without sanctions against this behavior) than by being productive. As a few violate the rules of the market, obeying the rule becomes less beneficial to others, and a few more will begin to violate the rules, which can lead to an unraveling as increasing numbers steal and defraud. Engaging in productive effort becomes foolish. The only way out of this prisoners’ dilemma is by imposing sufficiently severe penalties on theft and fraud so that they pay less than productive effort. Most people believe that only government can effectively impose such sanctions.

Government is also widely believed necessary for overcoming the prisoners’ dilemma in providing what economists call public goods–goods that, once provided to one person in a community, are available to all. Flood prevention is the standard example. The benefit you receive from preventing a flood does nothing to reduce the benefit your neighbors receive. With most goods, the same unit cannot be consumed by more than one person–the apple you eat is one that I cannot eat; the clothes you wear are clothes that I cannot wear, at least not at the same time. These goods are called private goods.

One might think that public goods are great–just provide enough for one person and you have provided enough for all. But public goods present a serious problem when, as is sometimes true, it is difficult to exclude people from benefiting from the good once it is provided. Again, flood prevention comes to mind. If my neighbor is protected against a flood, so am I. The problem is that it is difficult to get people to voluntarily pay for a non-excludable public good because each person can hope to free-ride from the payments of others. In other words, a non-excludable public good puts people in a prisoners’ dilemma.

To pick a simple example, assume that 100 people live in a flood plain and each would realize $500 worth of benefit from building a levee along the nearby river at a cost of $250 for each person. Clearly everyone would be better off contributing the $250 to build the levee. But no matter what each person believes others will do, he is better off not contributing. If enough others contribute, the levee will be built and he receives the benefits for nothing, but it would be useless for him to contribute if few others do. With everyone responding to the same incentives, no one contributes and everyone is worse off than they could be.

Supposedly, by being able to force people to pay taxes, government makes everyone better off by eliminating the prisoners’ dilemma we would otherwise face. By requiring that everyone either pay $250 in taxes or go to jail, the prisoners’ dilemma has been eliminated–and assuming the government uses the revenue to build the levee, everyone comes out ahead–the value they receive is greater than the taxes they pay.

Few Public Goods

However, there are far fewer public goods than claimed that really justify taxation and wealth transfers. There is hardly an organized interest group in existence that hasn’t argued that its activities are vital to national defense and therefore the government should take wealth from others for its benefits: wool subsidies (soldiers wear clothes), agricultural subsidies (soldiers eat), import restrictions on shoes (soldiers wear shoes), special tax breaks for mining (provides raw material for weapon production), programs for storing feathers (to insure the availability of down for jackets if we are involved in an arctic war), and the list can be continued. None of these things are public goods, and even if important to national defense, they are best provided in markets undistorted by government subsidies and transfers.

Also, even when a good is a public good, it is often possible to exclude nonpayers and provide it more efficiently through private markets than through government. For years economists have used the lighthouse to illustrate a public good–the benefit that one ship received from the beacon did not reduce the benefits other ships could receive. But in 1974 the Nobel prize-winning economist Ronald Coase pointed out that many lighthouses were privately provided in eighteenth-century England, with owners collecting payment from ships as they docked at nearby ports. A television program, once it has been broadcast, is a public good, but it can be (and generally is) privately provided by getting viewers to pay either indirectly by watching commercials or directly through pay-TV arrangements.

Arguments are often made for government expansion to solve problems that aren’t problems at all. Of course, some interest is always served by government “solutions” to nonproblems, and not surprisingly government often steps in when it is not needed with actions that create real problems, which–surprise–are used to justify yet more government action. Even when a prisoners’ dilemma prevents the private market from working with textbook perfection and it is theoretically possible for government action to improve things, it is seldom justified. Government action is invariably poorly informed, guided by motivations that have little to do with solving genuine problems, and almost always makes the problems it is supposed to solve worse.

One explanation for government’s poor performance is that although it can sometimes solve some prisoners’ dilemmas, it does so only by creating other, and commonly worse, prisoners’ dilemmas. This will be the subject of next month’s column.

Notes

Strong arguments have been made that private arrangements would arise without government coercion to establish and enforce the laws necessary for the proper functioning of markets. See Bruce Benson, The Enterprise of Law: Justice Without the State (San Francisco, Calif.: Pacific Research Institute for Public Policy, 1990), and David Friedman, The Machinery of Freedom: Guide to a Radical Capitalism (LaSalle, Ill.: Open Court, 1989), chapters 28-31.

Ronald Coase, “The Lighthouse in Economics,” Journal of Law and Economics, October 1974, pp. 357-76.

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